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When you apply for a guarantor loan, it isn’t your credit rating that the lender is most interested in: it is that of the person who has agreed to provide the security that the loan will be repaid. That’s because the lender accepts that you may not have a great credit record to start with and so will be basing its decision on the financial history of the guarantor.
The lender will want the guarantor to have a good or possibly excellent track record of managing their finances – always making repayments on time, never going into default, not having county court judgments (CCJs) registered against them and not having taken out too much credit in a short period of time.
Obviously this is the sort of financial track record that you want to develop so that, in time, you’ll be able to make applications for credit without the backing of a guarantor and be confident that you will be accepted. Guarantor loans are a great way of doing this: they allow applicants to use the financial track records of third parties not only to get access to lower interest rates and larger loan amounts, but also to start to rebuild their own credit records by making their loan repayments on time, every time.
How are credit scores worked out?
The three main credit reference agencies – Equifax, Experian and CallCredit – all gather data from credit and financial providers on every borrower and account holder in the country. That primarily consists of information showing outstanding loan and credit card balances, repayments histories and so on.
Other data used to make up a credit score includes whether a person is on the electoral roll, their addresses over the previous 10 years, any defaults or CCJs registered against them and a record of how many applications they have made for credit in the past two years.
From these figures, a credit score – a number between 100 and 1,000 is produced. The higher the number, the lower the risk that lenders will view you as.
How does a guarantor loan application affect this score?
It doesn’t. The lender will only perform a credit check on the guarantor because it wants a reassurance that the loan will continue to be repaid even if you get into financial difficulty. That also means that there won’t be a search recorded against your record when you make an application for a guarantor loan and, as we’ve already seen, credit searches can affect your overall credit score.
How will repaying a guarantor loan affect my credit score?
This is the good news. While your credit record is not assessed when you apply for a guarantor loan and that of the guarantor is, when you start making repayments on time this will be recorded on your credit records at the three main credit reference agencies. This means that so long as you repay your loans on time every time, you can be sure that you will be repairing or building a credit record that will enable you to borrow money on your own in the future.
It’s estimated that loan and other credit repayment history makes up nearly 40% of your credit score – more than any other single factor. Always making your guarantor loan repayments will improve your credit rating relatively quickly (so long as you don’t get into trouble with other credit agreements) and make you more attractive to other lenders.
The higher the loan, the more negative the effect
The size of the loan that you take out will have an effect on your credit score. This means that you will need to bear this in mind if you are applying for a guarantor loan primarily to improve your credit record. Your score will start to improve as you pay the overall balance down and so the bigger the gap between the original amount that you borrowed and the current balance, the better your score will be.
While the size of the loan you take out compared with your income is not apparent when you look at your credit record, many lenders now take into account your income when deciding whether you represent a low risk for borrowing. Obviously, this doesn’t apply to a guarantor loan where the initial decision is based on the credit record of the guarantor. But if you have a guarantor loan and apply for other forms of credit without a guarantor, lenders will look at your income. All of your loans and credit cards are compared with your income on this ratio and the higher the ratio is, then the more likely that this will lower your overall credit score.
Repaying too quickly
This may sound perverse but some lenders will avoid borrowers who regularly pay off their balances early. This is because every lender is offering credit to make a profit through interest charges. If you take out a guarantor loan or, indeed, any other type of loan, and then repay the capital sum and any outstanding interest early, the lender itself may not make as much money on the deal as it originally anticipated. Other lenders will see from your credit record that you have paid the loan back early and this may affect your ability to get credit from them. If you have credit cards that you repay in full every month, make use of every 0% introductory balance transfer offer you can find or simply don’t use them “enough”, you may find that you are more likely to be rejected when applying for other forms of credit.
Article provided by Mike James, an independent content writer working together with technology-led finance broker Solution Loans, who were consulted over this post.